Another Bite of Apple?

 | Jun 12, 2013 | 11:00 AM EDT
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With Apple (AAPL) severely underperforming the market for the last six months, investors are wondering if now is the time to establish a long position in the name for what is hoped to be the next great run in the stock. I, too, am wondering whether I should go long on stock again. I was once a huge Apple fan and bought the stock in March of 2009 (along with Research In Motion, which is now BlackBerry (BBRY)) as a basket play on smartphones.

I explained why I went negative on the stock on Dec. 12, 2012, reasoning that a price war was coming among carriers, which would decimate their ability to subsidize the iPhone and eventually put the squeeze on Apple's margins. So far so good: The stock is down 19% since that call. Although I didn't top tick it, the thesis is right so far.


What drove AAPL up to $700, and what is driving it down to the low $400s, are, unsurprisingly, the earnings,. Look at this chart that compares the next four quarters earnings-per-share (EPS) estimates to the stock price. Any statistician can appreciate that correlation.

Apple (AAPL) vs. next four quarters EPS estimates

Apple blew away the numbers on ramping volumes, expanding margins, and progressively more interesting products. That was then, however, this is now. The iPhone is far more expensive than Android, which is "good enough" as an iPhone substitute for most people. Carriers will be progressively less willing to subsidize the iPhone, so even if Apple brings out a new low-end model, margins will be under pressure. And let's face it, the company's ability to "wow" the world is diminishing, especially with Steve Jobs gone. The Developers Conference this week unveiled a new iOS7 with incremental improvements at best, a nice me-too iRadio service, and an iWork upgrade. Enjoyable stuff, but nothing that will change the world. The odds seem low for some major upgrade cycle driving a huge revenue and margin surge.

At some point, I might play a bounce in the stock. When estimates are washed out and start turning up, the potential for a meaningful move will be high, because, trading at 11x forward EPS, the stock is still pretty cheap. This will never again be a high multiple stock (not that it ever was), but it could someday have a 15x price-to-earnings ratio (P/E) if things are going right.

When (or if) the estimates eventually turn, I will play a bounce using way out-of-the-money, long-term equity anticipation securities (LEAPS). Because the stock collapsed from $700, there are call LEAPS still around the $700 strike and a year or more to expiration. You can get a safer long-term leveraged play on the bounce. The calls do not even need to go into the money; even if the stock moves into the $500s or higher, the LEAPS could gain by multiples. So tuck that idea in the back of your mind, but save it until the estimate cuts are done.

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